Friday, March 21, 2014

A Chinese Shadow Bank Bailout May Mean A Crash In U.S. Treasury Bonds

This article is adapted from a post which originally appeared at my Strategic Planning Group. Go to the preview page to see what it’s about.

China’s economy in 2014 is remarkably similar to America’s in 2008: Both were fueled by real estate speculation, both speculative bubbles a product of cheap-and-cheerful shadow-bank financing.

And just like the U.S. in 2008, China in 2014 is looking down the barrel of a Minsky Moment: The point at which servicing debt levels becomes unsustainable, and there are no reserve cushions large enough to absorb the losses.

Lots of people are pointing this out; Mish Shedlock had a piece about it this morning, and he and others are right to worry that a shadow banking collapse will be bad for China.

But it will be even worse for the U.S.: Because after all—unlike the United States in 2008—China in 2014 has the reserves to buy its way out of the hole it’s in.

In 2008, the U.S. shadow banking sector began its collapse when real-estate backed bonds turned out to be a lot dodgier than originally thought. This set off a systemic domino effect. We all know how the Global Financial Crisis of 2008 (GFC) played out.

Now, what did the U.S. Treasury and Federal Reserve do when the GFC hit? In other words, what did the American government do in the face of a collapsing financial sector?

Why simple: It threw money at the problem. But it was money that the U.S. government and Federal Reserve didn’t actually have . . .

The Treasury launched the Troubled Asset Relief Program (TARP), the $700 billion bailout of American banks.

The Federal Reserve launched QE (Quantitative Easing (QE), and its various subsequent iterations, eventually “expanding its balance sheet” (i.e., printing money) by some $3 trillion and counting; and implemented the Zero Interest-Rate Program (ZIRP), which meant that if you factor in inflation, the Fed has been paying banks to borrow money since 2008—and will continue to do so through at least 2015, as they have already announced.

So in other words, the U.S. Federal government went into massive debt to save the banking sector (TARP); and the American central bank essentially debased the currency (QE, QE II and III, as well as ZIRP).

All of this was to clean up the mess left by the U.S. shadow banking sector, and protect the wider economy from the knock-on effect.

TARP and especially the Fed’s machinations were considered “heroic measures” when they were implemented. Why “heroic”? Why so very novel and unorthodox (or so very orthodox if you’re from Zimbabwe or Argentina)?

Simple: Because neither the Treasury nor the Fed had ready cash to pay off the clean-up.

But China doesn’t have that problem. China has been a net creditor to the world. The Chinese government and the Chinese central bank have plenty of money on tap, in case needed.

Right now, China is sitting on some $1.3 trillion in U.S. Treasury bonds, not to mention a host of other liquid assets. China’s government and central bank have the ready cash to pay off the collapse of their shadow banking sector.

I’m not arguing that Chinese authorities were any wiser than their American counterparts, in allowing the explosive growth of the shadow banking sector and a surefeit of debt. What I am arguing is, unlike the U.S. in 2008, China has the tools to get out of this hole relatively easily.

But what effect will this have on U.S. Treasury bonds?

Well, it will depend on how the Chinese authorities decide to clean up their shadow banking mess.

(BTW, unlike in America, the Chinese will probably be ruthless with their shadow bankers—executions are definitely in the offing. Witness what happened a few years ago with the melanin-in-powdered-milk scandal: The responsible people were tried on a Monday, found guilty on Tuesday, and put in front of a firing squad I do believe that very afternoon. (Don’t you just wish American lawmakers had done the same to Dimon, Blankfein, et al.?) The Chinese, they don’t mess around.)

China’s shadow banking sector has exposure to both internal creditors and external (foreign) creditors. In the case of the former, if push comes to shove, the People’s Bank of China (PBC) can simply nationalize the shadow banking entity which has gone broke, then print enough renminbi to settle any counterparty claims, without this renminbi-printing noticeably affecting its exchange rate or the PBC’s balance sheet. The PBC certainly won’t hesitate to nationalize and unwind a teetering bank (as the U.S. should have done—but didn’t—in the case of Citibank), especially if such nationalization will restore internal confidence.

In the case of Chinese shadow banking entities with foreign exposure, the PBC can sell Treasuries to get dollars to pay off those foreign claims—and here we come to the nub of the issue.

If a major holder of Treasuries—such as China—all of a sudden decides to unload a big chunk of said holdings in order to get dollars so as to pay off a broken financial sector, what effect will that have on Treasury bond prices?

See why China’s current shadow banking problems matter in America? If China’s shadow banking sector is visited by a version of 2008’s GFC, Treasuries will take a hit, as the PBC sells them in order to get the hard currency to pay off foreign creditors.

An obvious objection to this is, Why would the Chinese honor foreign obligations of its shadow banking sector, especially if that entity is broke? After all, it allowed bond holders of Chaori Solar—the first Chinese shadow banking bonds to ever default—to eat the losses.

The obvious answer is, in the face of a single bond or entity’s failure, the Chinese government and central bank will proclaim caveat emptor—but in the face of a systemic collapse (such as what almost happened in the U.S. in 2008), the Chinese will shore up their shadow banking sector, no different from what the U.S. did, and for exactly the same reasons: A system-wide collapse would have devastating social and political consequences that would be far more costly than simply bailing out the shadow banks.

If and when the Chinese shadow banking sector collapses, the exact same potential outcome—generalized economic collapse—will be more than enough incentive for Chinese authorities to nationalize the sector and make their creditors whole.

(And this points to a corollary: It might be a shrewd investment to pick up some extra-cheap Chinese shadow-banking products once the sector looks on the verge of system-wide collapse. The warning, though, is that the buyer has to know when the Chinese shadow banking sector looks to be on the verge of systemic collapse—and pick products from entities that the Chinese government will not allow to fail, or at least not allow to default.)

How will the American Treasury and the Federal Reserve react to a Chinese sell-off of Treasury bonds to pay for a shadow banking bailout?

My thinking? Federal Reserve Chairwoman Janet Yellen will print and buy—in other words, more QE, which as I’ve said more than once is nothing but gasoline thrown on the unlit bonfire that is dollar hyperinflation.
I have two books out, which I hope you will enjoy: Hyperinflation In America is a look at how hyperinflation could take off, how to prepare for it, and how to invest so as to take advantage of it. The other is A Secret History of The American Crash, which explores the social and sociological effects of a prolonged, catastrophic failure of the American economy.

Click on the links to check out free samplers of both books. Thank you, and enjoy! GL


  1. Replies
    1. The Chinese credit market is now $24 trillion in size, or 2.5 times the size of their GDP. This makes their debt crisis far worse than what took place in the U.S. $1.3 trillion in treasuries would not even cover the down payment needed for the bailout.Selling treasuries would also add strength to their currency at a time when they would need to devalue to help pay down existing debts and stay competitive globally. It is far more likely they will just print.

  2. Two points:
    1-Despite all the taperTalk, the only thing that matters is what the Fed actually does, which strangely enough is a completely different graph than the talk. Besides, there are limits to QE imposed by buying up all the securities the financial system uses for collateral and by the percentage of treasury securities there are available to buy.

    2-The POCB also has a balance sheet. All those American treasuries balance with the issue of Remnimbi. They buy treasury bonds with dollars earned in America, but pay for them with Remnimbi. Selling would mean shrinking their balance sheet (deflationary) or printing up even more liquidity, which is part of what has fueled the credit binge to begin with.

  3. US treasuries are only guaranteed to be exchanged for dollars at maturity, not earlier. If the FRB didn't buy the Treasuries, they would have to be sold in the secondary markets which would create a demand for dollars which would increase their value against other currencies and drop the value of treasuries at the same time until some sort of equilibrium is met. You can be assured that the secondary markets in the US will support a predetermined value of treasuries with FED intervention providing dollar liquidity to do so. Without the orderly secondary markets and FED intervention, there would be a spike in dollar valuation and a simultaneous drop in treasury valuation and corresponding spike in interest rates. Not something that we need in the fragile state that we are in.


    Pure speculation and a work of fiction, not fact. You have to indulge in a hefty dose of " Gloom and Doom" while buying into the very worst case scenario for America in the next 7 years. You could also liken it to the fate of ancient Roman city of Pompeii prior to the eruption of Mt. Vesuvius. Obviously, judgement is complete and the end final.

    I would suggest we still have time, options and choices still left to avoid such a drastic outcome. However, none of them will be easy or painless at this point. America has wasted the last five years and needs to reconsider our collective direction this November.

    - H. Craig Bradley

    1. Our American youth will come with sleeves rolled up!

      "Dice has now successfully managed to persuade Americans in his area to agree to repeal the First, Second, Third, Fourth , Fifth, Sixth and Seventh Amendments, as well as the entire Bill Of Rights."

      "What's a FEMA Camp?"

      Students Sign Petition To Have Gun Owners Executed In Concentration Camps. You can read it on :

      "“They was like...' university student???

      ...and you wonder why the US is in fast track decline?

      'Common Core' is a strategy for eliminating critical thinking and dumbing down our next generation to facilitate compliance.

      Our ignorant elected local officials are allowing it.

      So students are learning that Christianity is bad, our bad founding fathers, sex toys, deviation, global warming lies, Saul Alinsky, math is consensus, Muslim tolerance, Multi-culturalism, Political Correctness, taught to think like a powerless victim but encouraged to leave school to protest with OWS Marxist, anarchist idiots?

      No time for personal finance or the Federalist Papers? Of course not, the globalists forbid such information, it would expose the whole thing and that would lead to student riots.

      "What's the federalist papers?"

      Lord knows the Americans couldn't keep it, as Ben Franklin obviously had concern.

      Can you name a country that starts with the letter 'U'?
      Some answers: Europe (Urope) and Utopia:
      youtube: Lunch Scholars'll understand how our liberal left progressive public school system had everything to do with the fall of the USA. That's what we get for having under achievers and low information voters charged with teaching our next generation.

  5. Gedankenversucht on probability estimates for catastrophic events

    In a long and lucid interview yesterday on USAwatchdog, James Sinclair included, among other ideas, the possibility that in a hyper-inflationary collapse, the price of gold could go to as much as $50,000 per ounce. Shortly afterward Gary North posted on his own site a snide editorial referring to this as "Jim Sinclair's Senior Moment."

    Instead of spouting raw opinion, North might better have used a calculator and some brain cells to carry out a Gedankenversucht (thought experiment) on the possible future based on the experienced past.

    Look at some simple facts and numbers:

    $1917.90/ ounce (high price for gold in 2011).

    $1917.90/$35 (the price at which I began buying gold in 1971) = 54.8

    $1335.90/ounce (today's close) x 54.8 = $73,207.32

    The time span is longer than from now until 2020, but also the price is higher than $50,000.

    In my experience there are times when trends can run far higher, far faster, than one can foresee in calmer periods. When emotions run high, prices rarely achieve equilibrium plateaus, instead dropping far lower or rising far higher than would be a "reasonable" expectation.

    I can recall, after buying coins in the early 1970s quietly by mail and in near-deserted coin stores for several years, toward the end of the decade seeing frantic people lined up six deep in front of the counters, trying to buy ANY gold or silver at prices far higher by multiples than I had a few years before. My older friends from Germany have stories about infinitely more frantic times. These things do happen. They are neither highly predictable nor totally unpredictable.

    I remember in the 1970s running some money in gold from $35/ounce to $600 per ounce (17x), and over the same period Mr. Sinclair rode the price to $850 (24x).

    Some -- unfortunately most -- humans have a very bad habit of believing that if something has not happened yet, it never will. On that score Nassim Taleb has written The Black Swan and, even better, Antifragile.

    I have lived through far, far too many six sigma events for their probability really to be anywhere near as low as six sigma.

    Does any of this guarantee that James Sinclair is correct in the possible gold price that he mentioned? On this score I will quote my Chinese daughter-in-law who survived "re-education" under Chairman Mao: "Yes. No. Maybe so."

    As a scientist who has dealt daily with exceedingly rare events over a professional lifetime of nearly half a century, I try not to block out emotionally things that are conceivable rationally, and try not to mislead myself that I can even come close to estimating the probability of events for which I cannot estimate any exact causal nexus.

    Robert B. Eckhardt, Ph.D.

  6. Jim Sinclair has been crying wolf seemingly for ages. Remember when Mr. Sinclair stated that gold would never see below $1600 per ounce after the Cyprus banking problems?

  7. the ONLY thing wrong with this theory is the money being printed to buy these treasuries coming back IF the chinese redeem them is this money is not going to go into the mainstream US economy. so no hyperinflation...

    it's not until these huge sums of money are released into the REAL economy that the effects take hold.

  8. we know the chinese always plan ahead, thats why they have been accumulating gold. They will announce how much gold they have and it will shock everybody. In effect what you will have is a revaluation of gold by the chinese. There will be no need for a mass selling of bonds.


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